February 27, 2009

In order to understand how a down turn in the US housing economy has caused an implosion of the banking system, you will need to understand how fractional banking works. The crisis is built into the system and should be no surprise to anyone.

Fractional reserve banking is a banking system in which a bank can loan out more than the reserves, or deposits, it has available. The national banking regulators periodically change the percent of reserves required, but usually it’s around 10%. It is never 100%.

This is how is works in its simplest form.

An individual gets paid $1000 and goes to Bank A and deposits that money. The bank in turn may lend out $900 of that $1,000 to another individual (B) as a loan and collects interest. That individual B with $900 goes to Bank B (or it could be the same bank A), and deposits his $900, and Bank B loans out $800 of that $900 to individual C. And so on.

If this continues, it is possible, very probable, that the original $1,000 can create $10,000 in created money within the economy!

The problem: if any one of the loans in the chain defaults, the entire chain can collapse. If the individuals decide to take the cash (their original deposits) out of bank, the chain collapses. The interest payments to the bank also play a role here, but for now, we will stick to the basics. Interest payments are how banks make their money.

A minor downturn in the market can cause the chain to collapse, but the bank will just refrain from lending for a while until more individuals pay back their loans or deposit more money.

What makes this time so much worse?

The banks took the loans (most of them home mortgages from the housing bubble) and sold them off to Wall Street and hedge funds as CDOs and SIVs (types of securities based on the buying and selling of debt). Thus removing themselves from a vested interest in whether the loan gets paid back or not. They do not own those loans anymore, Wall Street does. They simply broker the deal and pass the interest payments to Wall Street or whoever purchases the security.

This is why home owners in foreclosure are demanding to be shown who owns the loan. The bank does not and should not be able to foreclose in the court system.

The banks decided that CDOs were a great deal, because they get paid up front from Wall Street for a large portion of the loan amount and can take that money and loan it out again. Normally, they would have to wait 30 years to get paid back from the home owner or at least until they decided to sell.

CDOs accelerated the implosion, because it is debt upon debt. This new chain reaction has also caused the defaults in home mortgage market to effect the Wall Street market. Normally, something like this would be contained to the banking system.

There are many other details that helped make this the worse financial crisis in history, which I will go into in later blogs. For now, it is important for you to understand that this crisis is built into the system.

The Federal Reserve Bank is the ultimate in reserve banking. They loan the US government money, just like a bank would loan an individual money. The Federal Reserve Bank has an IOU from the government for a loan, they collect interest on that loan from the government. The Federal Reserve puts money into the government’s account at their bank and the government spends that on programs, war, and running the day-to-day operations.

Where does the Federal Reserve get this money? They create it out of thin air! Yes, that’s what I said. It is perfectly legal and was voted into law by the Federal Reserve Act of 1913. Now the Federal Reserve does have some reserves like other banks, however, they have the same amount of dollars in reserves as they did in 1913.

In light of our discussion in part 1, the real value of those reserves are 93% less, so they really have zero dollars.

A couple of things to take away from this post:

Money is created out of thin air. As we have seen, it can evaporate just as quickly.

The US Government must continue to borrow money from the Federal Reserve Bank.

The US Government must borrow from the Federal Reserve at least the amount of interest due to the Federal Reserve on past loans. (They tend to borrow much more.) At some point in the future, the government will only be able to pay the interest. This is exactly like you paying only the minimum payment on your credit card. If you continue borrowing and only paying interest, you will never pay your debt off.

It is built into the system.

Now that you understand two key concepts, fiat currency and fractional reserve banking, and how the current crisis is built into the system, what can you do about it?

February 26, 2009

In order to understand why the financial crisis is occurring, there are a few things that you need to understand.

The United States likes to print money to give the illusion of growth. They are able to do this because legally they can through the Federal Reserve Bank and because the US Dollar is not tied to any form of value, like gold, or any restraint, like a cap on the money supply. A fiat currency system, used in this way, will create inflation and decrease in the purchasing power of that currency. It is happening now in the United States and hyperinflation is just a matter of time. Zimbabwe is an example of the government printing too much money. It has caused the currency to be worthless and inflation to double every few months.

Fiat currency is money (either paper cash or credit that is borrowed into existence). It is not tied to anything of value except the goodwill of the nation printing it.

The government can control the amount of money they print, but they can not control where is goes or how it moves. Printing money will always end up as inflation in prices down the road. It slowly destroys the purchasing power of the currency. Since the Federal Reserve’s conception in 1913, the US Dollar has lost 93% of the value of the goods and services it can buy.

Some would say that inflation is good because the price of assets have increased by 93% in tandem. That’s a nice idea, but there are two problems with that statement. One, it just means that assets have increased with expenses, or you broke even. Two, if you don’t own assets, you are screwed.

In the 1950’s and 1960’s, a family of four could live off of the income of one family member, usually the father. By the 1970’s thru today, there must be two bread winners for a family of four to live in the same fashion or less. That is the horrible effect of fiat currency on the culture in the United States.

There is a distinction between the cost of something and the value of something. Fiat currency is designed to give the illusion of more value when there isn’t any added value.

Make sure you are valuing your investments adjusted for the real rate of inflation or you will come up with a distorted value of your return on investment. It will impact your life in retirement, because your money will buy less than you thought it would.

February 23, 2009

Latvia government has collapsed. Now Iceland has a friend. “Red Rover, Red Rover, send Latvia right over.” What former Eastern block country will be next to implode? The scary thing is we don’t know how interconnected Latvia’s economical status is with main Europe.

There were rumors last weekend that Eastern Europe was on the brink, apparently they were true.

Europe is doing the same thing as United States is with the banks….a controlled implode, not a panic.

Let me be very clear here, there is no question that the entire economic system is gone..dead, the governments are using all their resources, media, finance, political resources to control the implode.

Mike, who has written the book, Investing in Gold and Silver, has a very good take on the market for last week and this week.

I, like Mike, trade on large trend movements, not day-to-day trading. Day trading is too much of a headache.

Plenty of optimism for gold and silver markets, if not now, later this year.

The final ideas to take away here is:

We are in a twenty-year bull market in the large wave 3 (trading $700-$3,000). There will be movements within that range. The volitity has been and will reflect the lack of confidence in the overall markets and global economic system. The confidence cycle is hitting a peak late April of this year.

All the market media and market manipulation can not change those two things. Cycles may be delayed, but never avoided.

Are your investments positioned for another down turn in confidence in the market sometime around late April 2009?

Saying, “…help as many as nine million families refinance their mortgages or avoid foreclosure…” is also presenting something as fact that does not even stand up to the slightest scrutiny. The $75 billion price tag divided by 9 million gives us a value of $8,333.33 for each of the nine million homes. There is simply no possible way that $8,333 each is going to make the difference between 9 million people keeping or losing their homes. It might if that was applied to this year’s balance gap, but over the life of the loan? No possible way.

The math doesn’t add up here. The foreclosure and mortgage crisis will not be contained by this plan. It is key to address this issue before any recovery can happen. This plan will delay recovery. The entire commentary by Chris is very good based off a NY Times article today.

IBM is moving all jobs to other countries except customer face-to-face employees. Expect to see MicroSoft, maybe Google, do the same thing. Wonder where they are moving to? Can you say “east Asia”? Learn another language and the customs of Asian countries, if you want a job in the future or modify your career choice. The next 20 years will be completely unlike the last 20 years. Be flexible or be very disappointed.

This is what the US did (and other things) to get cheap oil from the Saudis in the 70’s and 80’s. (Gas was high in the 70’s because of inflation in the US Dollar, not the price of oil.)

The good old days, when America lent money, not borrowed it. China has 3 trillion in cash lying around, we have an $11 trillion dollar deficit (not counting Social Security and Medicare future obligations).

We are doomed, take cover quickly. Protect yourself, because the government is too strapped to do it for you.

February 18, 2009

If you plan to live on a pension or partly on a pension, take it out of your retirement equation now.

Companies are underfunded and will continue to be underfunded for three reasons:

They are invested in the same markets as everyone else, they have lost 40%.

The rules for companies to add to their pension principle have been “relaxed”. This will put them further behind in future funding.

They will not have enough time to catch up on their losses before the baby boomers retire in force.

Pensions are underfunded, but have no fear, the PBGC (largest pension fund insurer) will cover any losses. They seem confident in this article (linked below) that these losses are a non-issue.

Strange when the last line of the article states:

The PBGC successfully shaved nearly $3 billion off its deficit in the 2008 budget year, which ended Sept. 30, primarily because 13 auto parts makers reorganized and didn’t dump their pension liabilities on the PBGC.

This insurer is running a deficit and the reason it is not larger is because more companies didn’t go bankrupt. That’s reassuring. What do you think, more or less bankruptcies in the future?

Of course, this insurer will implode just like AIG. Then, the government will be in charge of how much you get and when. Will they give you the same terms as your company? As PBGC? PBGC only gives pensioners under their umbrella a percentage of what was originally promised.

February 17, 2009

Last night Eastern European countries came close to imploding on threat of national defaults. European markets plunged and the US market started its secession down 3%. It would have been uglier if the IMF (International Monetary Fund) didn’t step in last night. They apparently they have their own plunge protection team.

Anything can trigger this unstable global market. Eastern European (former Soviet Block) nations gambled high percentages on currency-based derivatives. The volatility in the currency markets is causing stress on their national financial health. There was a scare that any default in Eastern Europe could catch hold in main Europe (as many European banks financed these derivatives).

February 16, 2009

This whole lack of Security and Exchange Commission oversight in the Madoff scandal, insider trading before bank implosions, and the fact Freddie and Fannie haven’t filed formal annual financials since 2004 (begging the conclusion that they have been insolvent since then), is looking more and more like the Vatican’s child molestation policy. Move the offender to another area and don’t say anything.

Here is another example of this type of move: the current SEC director to the private sector and a private sector banker from Deutsche Bank to the SEC. Guess what, the American investor will get screwed again.

In an AP article:

The US Securities and Exchange Commission said Monday its enforcement chief has quit, following criticism over apparent failure to uncover the alleged 50 billion dollar investmentscam run by mastermind Bernard Madoff.

SEC enforcement director Linda Chatman Thomsen planned to return to the private sector, the commission said, praising her three year stint as “a historic period.”

US lawmakers last week gave the commission a severe tongue-lashing for not moving swiftly to uncover the Madoff scandal despite ample warnings, including by a private securities sleuth who said he tried for nearly a decade to sound the alarm on Madoff.

It is not known who will replace her but it was reported over the weekend that former Assistant US Attorney Robert Khuzami, currently the general counsel for the Americas at Deutsche Bank, was a top candidate.

No investor with an ounce of common sense will risk putting money in a country’s financial market that has no true oversight. The good money has already left the US dollar, please follow their example. Or get crushed in the rush to the exits.

Here is a good link to non-biased journalism. They have a running tally on bailout money and promises of the government.

February 15, 2009

If you have all of your money for personal or business use in one bank, you have put your all your money on a roulette wheel.

These are the banks that have imploded. The FDIC has a system in place to orderly close the insolvent banks as they don’t want to cause a panic. When the panic does happen, banks will implode in a not so orderly fashion. The FDIC is not set up to handle that, nor do they have enough cash to cover everyone’s account.

You will probably get your money back if you are under the $250,000 limit, but what will you do to pay bills in the meantime?

February 12, 2009

Another wave in the financial crisis coming soon. Banks are not solvent and are relying on the newest bailout to survive. The fundamental problems have NOT been addressed. This is NOT fixed.

Prepare now, if you have not already.

Here are some quotes from a story about the “emergency meeting” at Goldman Sachs after Geithner’s Tuesday Press Conference. Top Goldman executives were there AND top hedge fund operators:

What the group concluded was that the longer the plan takes to produce, the more difficult the situation becomes. Some (Goldman executives) actually had met with officials at the New York Federal Reserve after Geithner’s speech and were told the plan is still weeks away. That wasn’t received well.

The worse the economy becomes and the securized products held by the banks lose more value.

Ken Griffen, the founder of Citadel, stressed the need not merely to fix the prices of the securitized bonds, but also that any plan must stabilize the root cause of the problem—the mortgages themselves. And he came up with several ideas to spur home-ownership that could revive the housing market.

The banks are well aware that if they had to disclose to the public the true value of their “assets” (i.e. derivatives instruments), they would be bankrupt. They have to get those “assets” off their books by selling them to the government, collecting more cash from the government to off set them, or wait until the market will buy them. There is a reason why the market doesn’t want these “assets”, the taxpayer should not want them either.

I don’t know who Mr Griffin thinks he is going to give a mortgage to, no one has job. True employment rate is at 18%. People that have a mortgage are struggling to pay it.

Bottom line is the Big Banks are worried. That means it’s not over.

I agree with several of the economists out there, banks will be nationalized at some point. That’s probably the real reason banks are nervous. The executives will then become federal employees, our public servants.